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Derivatives

Derivative contracts are capital market instruments based on the price of an underlying asset. They come in three types: futures, forwards, and options. Professional traders will undertake fundamental and technical analysis to determine contract structure and profitability. Learning derivative trading strategies is crucial for exponential growth. It's important to understand terminology, future and option pricing, payoffs, premiums, and trading strategies. Gain comprehensive knowledge for successful live market trading, even as a novice.

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A Derivative Contract is a type of Capital market Instrument which is created between parties based on the price of the underlying instrument.

There are three types of participants in Derivative Markets- Hedgers- one who trade to reduce risk, Speculators- one who trade to take large risk by anticipating price change and Arbitrageur- one who trade to profit from price differences. The Derivative contract can be mainly of three types Futures, Forward, and Options.

So what are these contracts? With Forward Contract, the contract to buy or sell underlying assets is agreed upon at a predetermined price at a future date.

A future Contract is similar to a Forward Contract with the difference that it is a standardized contract whereas a Forward Contract is a customized contract.

Options Contracts are the most traded contracts which give the buyers and sellers the right to limit losses and profits while trading.

So these contracts do not allow you direct ownership of the company which is possible while Stock Trading.

Why learn Derivative Analysis?

It is important to understand the contract fundamentally and technically before agreeing to it. Professional traders will undertake fundamental and technical analysis to frame the structure and profitability of the contract before taking the decision.

Running Fundamental Analysis for Derivatives is the same as analyzing the economic and intrinsic values of underlying assets in a particular trade.

Whereas Technical Analysis for derivatives is to identify future trends of the underlying asset in the contract. These involve using various indicators and strategies.

How beneficial is Forward Contract?

The Forward Contracts are not traded in Stock Exchanges and are typical customized contracts. This is formed between parties on buy and sell of a particular asset at a predetermined price in future.

  • So one party will have a long position that is to buy the underlying asset and another party will have a short position that is to sell the underlying asset.
  • This contract is exposed to Counterparty Risk because it is a bilateral contract.
  • Physical Delivery is more common for Forward Contracts.
  • Forward contracts are mainly used for Hedging and Speculating.

What are Futures Trading all about?

The most popular way of trading in the Financial Market is via Futures Trading. Before venturing into Futures Trading, efficient share of Research is utterly necessary.

  • It is required to develop the right trading strategy, have patience and learn from trial and error to structure the appropriate framework for you.
  • You should have proper grasp over Contract Size, Trading cycle, Payoff from Long Position, Payoff from Short Position, Expiry Date and Settlement Date of the contract.
  • The pricing of Futures Contract is based on two models of Cash & Carry Model and Expectancy Model.
  • Hedging with Futures is simple and executed under Long Security of Underlying Asset or Sell Futures and Short Security of Underlying Asset or Long Futures.
  • Speculating with Futures is extremely rewarding if speculation is correct. Bullish on Securities, Buy Futures. Bearish on Securities, Sell Futures.
  • Arbitraging through Futures requires good fundamental skills. If Futures is overpriced then buy spot and sell futures and if Futures is underpriced then sell spot and buy futures.

What are Options Trading all about?

Future Contracts generate unlimited profits as well as unlimited losses. But with Options, we can limit these losses. The choice to enter and exit the contract is only available in the Option Contract.

  • When you choose to buy an option contract with a right and no obligation at a predetermined strike price, it is called a Call Option.
  • Call Options are used when the spot price is higher than the strike price and the market is bullish.
  • Whereas when we choose to buy an option contract with a right to sell at a predetermined strike price, it is called a Put Option.
  • Put Options are used when we see that the strike price is higher than the spot price and the market is bearish.
  • Long call, the call option buyer will have losses up to the Option premium.
  • Short call, the call option seller will have profits up to the Option premium.
  • Long call, the call option buyer will have profits when the spot price (future price) is higher than the strike price (contract price).
  • Short call, the call option seller will have losses when the spot price is higher than the strike price.

Why dig into Options Trading?

With Options Trading, you can double your money in a single day. But yes, so much return will come with higher risk.

  • The first benefit that comes with option trading is the amount of capital required. It is very less compared to other stock trading instruments as the amount consists of only the price of the underlying asset.
  • The second benefit is that with the Put option, you can hedge trading from price drops. You can offset exposure to price fluctuations with options trading.
  • The third benefit is leveraging returns by option trading.
  • The third benefit is leveraging returns by option trading.

So try to dedicate some time to learning Derivative Trading Strategies to grow money exponentially with correct trading. It is essential to have comprehensive and in-depth knowledge about derivatives instruments. This section will not only introduce you to various Derivative Market Terminologies but also teach you various concepts of Future Pricing, Option Pricing, Payoffs, Option Premiums, Options and Futures Trading Strategies and much more with Live Market exposures.